Rising Interest Rates

Rising Interest Rates

by Mary Suplee on Nov 12, 2018

I've been happy to see the recent good economic numbers, particularly the effect this has had on the bond markets. Finally, we’re starting to earn a return for saving. The real yield, that is the interest rate above the rate of inflation, has moved to 1.08%. 10 year treasury bonds are paying 3.2% and inflation is running about 2.1%. That is the biggest spread above the inflation rate since 2011.

Why is this important? Because for extended periods over the last seven years, the interest rate investors earned on US treasuries has been less than the rate of inflation. It was in effect a tax on saving. If you buy treasuries and get back less than the rate of inflation, then you're going backwards. This is before the privilege of paying income tax on your interest.

Higher interest rates also provide a margin of safety for investors. When you have larger interest payments coming in periodically, you have more cash to reinvest. When rates go higher you can take advantage of the new rate by reinvesting your earnings in new higher-paying bonds. While rate increases have caused the price of some bond portfolios to drop over the last six months, they tend to be self-correcting. Investors reinvest their interest payments in new higher yielding bonds when rates go up. But above all else, higher rates help us earn a return for taking on risk.

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